Chapter 5 Discussion Questions 5-1 Discuss the various uses for break-even analysis Such analysis allows the firm to determine at what level of operations it will break even and to explore the relationship between volume, costs, and profits 5-2. What factors would cause a d ifference in the use of financial leverage for a utility company and an automobile company? A utility is in a stable, predictable industry and therefore can afford to use more financial leverage than an automobile company, which is generally subject to the influences of the business cycle. An automobile manufacturer may not be able to service a large amount of debt when there is a downturn in the economy Explain how the break-even point and operating leverage are affected by the choice of manufacturing facilities(labor intensive versus capital intensive) A labor-intensive company will have low fixed costs and a correspond ingly low break-even point. However, the impact of operating leverage on the firm is small and there will be little magnification of profits as volume increases. a capital-intensive firm, on the other hand, will have a higher break-even point and enjoy the positive influences of operating leverage as volume increases What role does depreciation play in break-even analysis based on accounting flows? Based on cash flows? Which perspective is longer term in nature? For break-even analysis based on accounting flows, depreciation is considered part of fixed costs. For cash flow purposes, it is eliminated from fixed costs The accounting flows perspective is longer-term in nature because we must consider the problems of equipment replacement What does risk taking have to do with the use of operating and financial Both operating and financial leverage imply that the firm will employ a heavy component of fixed cost resources. This is inherently risky because the obligation to make payments remains regardless of the cond ition of the S-159 Copyright o by The McGraw-Hill Companies. InCopyright © 2005 by The McGraw-Hill Companies, Inc. S-159 Chapter 5 Discussion Questions 5-1. Discuss the various uses for break-even analysis. Such analysis allows the firm to determine at what level of operations it will break even and to explore the relationship between volume, costs, and profits. 5-2. What factors would cause a difference in the use of financial leverage for a utility company and an automobile company? A utility is in a stable, predictable industry and therefore can afford to use more financial leverage than an automobile company, which is generally subject to the influences of the business cycle. An automobile manufacturer may not be able to service a large amount of debt when there is a downturn in the economy. 5-3. Explain how the break-even point and operating leverage are affected by the choice of manufacturing facilities (labor intensive versus capital intensive). A labor-intensive company will have low fixed costs and a correspondingly low break-even point. However, the impact of operating leverage on the firm is small and there will be little magnification of profits as volume increases. A capital-intensive firm, on the other hand, will have a higher break-even point and enjoy the positive influences of operating leverage as volume increases. 5-4. What role does depreciation play in break-even analysis based on accounting flows? Based on cash flows? Which perspective is longer term in nature? For break-even analysis based on accounting flows, depreciation is considered part of fixed costs. For cash flow purposes, it is eliminated from fixed costs. The accounting flows perspective is longer-term in nature because we must consider the problems of equipment replacement. 5-5. What does risk taking have to do with the use of operating and financial leverage? Both operating and financial leverage imply that the firm will employ a heavy component of fixed cost resources. This is inherently risky because the obligation to make payments remains regardless of the condition of the company or the economy